Mon, 20/10/2008 - 07:00
Jerry Haworth examines the factors and investment thinking that have driven the significant performance of New Zealand-based 36 South's strategies in recent years.
HW: What is the background to your company?
JH: 36 South Investment Managers has been operating since 2001. The underlying strategy is long volatility, long "tail risk", initially manifesting as the Kohinoor Series One Fund (upper and lower tail risk across a range of market opportunities), and the Regent Fund (precious metals). Since then we have launched the Black Swan Portfolio, a risk aversion protection product - and Dresden Green - a yen volatility product. After initially introducing NZD taxable products, all funds are now available as USD offshore funds.
Key principals and investment committee:
Current firm AuM is USD 43 million.
HW: Who are your service providers?
JH: We prefer to use high quality, recognisable names for our international product, e.g. HSBC, Rothstein Kass.
HW: Has your performance been as per budget and expectations?
JH: We have a range of funds, all of which have been performing close or in excess of expectations considering past and present environments. Our Kohinoor strategy is annualizing at circa 18% over almost 7 years of track record. Our Black Swan portfolio to mid-October is up around 50% since inception in the middle of January this year…and the offshore fund representing our Regent Fund precious metals strategy is up over 100% from inception in August 2007.
HW: How have you managed to outperform your peers in the more established hedge fund centers?
JH: We believe we have a well-established and well-differentiated approach to finding extreme value options. It also helps to be out of the "noise" - which we believe is one of the key reasons that New Zealand managers overall appear to outperform their peers (see Ernst and Young New Zealand Absolute Return Index).
A good example is our house view from 2006 that US lenders were selling inappropriate borrowing structures to people who couldn't afford it which in turn would lead to severe balance sheet issues. When marketing that particular strategy into the US and Europe it was a trade that many didn't intuitively take on board, not being part of the established paradigm at the time.
We established short positions in a well-known sub-prime lender using long-dated out of the money options. Another example is buying oil calls as speculators liquidated positions in mid-2006. We sold our oil positions in May 2008 - just as some well-known commentators were predicting USD 200 per barrel.
HW: Have there been any significant recent events such as new launches?
JH: The Black Swan Portfolio product was launched in January 2008, designed to be 2.5% of a portfolio and provide a substantial return for the portfolio in extreme risk aversion events.
HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?
JH: Our target client base is typically institutional although we do have some high net worth individuals as customers. We have had some success in marketing into Europe.
HW: What is the investment process of your fund?
JH: We have a four-stage investment process we call the Quadrivium which incorporates implied volatility, technicals, sentiment and fundamentals. The most important component in terms of getting the payoffs in many multiples against initial premium spent is implied volatility.
We use our proprietary GIVIX indices on a "top-down" basis and an automated scanning process to find those sectors and individual options that fit our criteria in terms of historical ranges, volatility and type of trade opportunity e.g. the "mid-trend power bear move" is one of our classifications. Trades may also be driven by a view on sentiment - typically where there is an extreme.
HW: How do you generate ideas for your fund?
JH: The scanning process is central to the initial trade generation process however we still end up with quite large short-lists - so the combined investment experience of the investment team is used to refine the short list. Each of the three investment committee members has a preset weighting and each trade is scored in terms of the Quadrivium - then weighted according to the individual team member's weighting within the investment committee. It is a structured discretionary approach.
HW: What is your approach to managing risk?
JH: A long volatility, long option strategy is naturally going to have limited risk characteristics - however it is not without risk. We have a "premium budget" within which we limit our annual spend on new option premium. Our GIVIX allocation process ensures we do not allocate new premium spend on asset classes that are expensive in terms of implied volatility. We also use standard risk management metrics to maintain in-house risk allocations at appropriate levels.
HW: What are your views on volatility at this current time in the markets?
JH: We believe volatility is in a medium-long term peaking phase - with actual volatility likely to stay high for a little while longer - however implied volatility is close to peaking.
HW: What opportunities are you looking at right now?
JH: We are looking for opportunities to add value against our existing long volatility, long kurtosis ("fat tail") portfolio positions within the Kohinoor portfolio. This will likely mean taking some short-dated short volatility opportunities against existing long-dated positions. We will never be net short volatility however.
HW: What events do you expect to see in your sector in the year ahead?
JH: We expect to see volatility peak with markets trading within large but limited ranges. There could be some consolidation of recent trends but what was a financial system phenomenon will continue to infect the real economy. We expect interest rates to move lower and have positioned ourselves accordingly - especially in Australasia.
HW: How will these changes/future events impact on your own portfolio?
JH: We expect our interest rate positions to do well. We also expect some of our "real economy" bear positions to continue to perform although there may be a plateau period in between.
HW: What differentiates you from other managers in your sector?
JH: We believe we have a robust investment process driven by a team highly experienced in selecting long-dated out of the money option opportunities. Our performance record speaks for itself.
HW: Do you have any plans for similar/other product launches in the near future?
JH: We are considering whether to launch a product to take advantage of what we believe is a medium to long-term peak in implied volatility.
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